2.7 Role of Government Flashcards
reasons why governments want to intervene in markets
To earn government revenue
To support firms
To support households on low incomes
To influence the level of production
To influence the level of consumption
To correct market failure
To promote equity
Main forms of government intervening in the market
price ceiling
price floor
indirect taxes
subsidy
What are price controls
The setting of minimum or maximum prices by the goverment
aims of a price ceiling
increase consumption of the good or service.
reduce the price of certain goods or services for low-income consumers.
prevent exploitation by monopolies
common situations where maximum price controls are used to ensure the availability of:
low-cost food for low-income earners.
affordable housing for low-income families.
price ceiling may produce several consequences
It produces shortages.
It generates a rationing problem.
It promotes the creation of parallel (black) markets.
It eliminates allocative efficiency and generates welfare loss.
There are consequences for market stakeholders.
What is a price ceiling and draw the graph
Is a maximum price set below the equilibrium price, in order to make goods more affordable to people on low incomes
shortages
not enough of the good being supplied
non-price rationing
once shortages occur price mechanism no longer achieves its rationing function, so non-price rationing methods occur e.x waiting in line, favoritism
underground markets
illegally selling good above legal maximum as since shortages are present consumers are willing to pay more to get it
under allocation of resources and allocative inefficiency
not enough resources are allocated to production of the good, society is worse off due to underallocation and allocative inefficiency
negative welfare impacts
MB > MC, creating welfare los and allocative inefficiency
Consequences of price ceiling for stakeholders
Consumers - partly gain and partly lose as consumers who are able to buy the goof purchase it at a lower prices however some consumers remain unsatisfied since they cannot purchase the food
producers - worse off, as they sell a smaller quantity at lower prices and revenue drops
workers - fall in output means some workers likely to be fired, resulting in unemployment
government - no gains or losses for the government budget
What is a price floor and draw the graph for it
A minimum price set above the equilibrium price, in order to produce income support to farmers or to increase wages of low-skilled workers
price floor
government sets a minimum price above the equilibrium price, preventing producers from selling their product below it. This is done to protect producers, usually in the case of commodities and in the labour market.
aims of price floors
to increase the income of producers of goods and services that the government considers important, such as agricultural products, which are subject to large price fluctuations or great foreign competition.
to protect workers, by setting a minimum wage that ensures they earn enough to have a reasonable standard of living.
consequences of price floors
It produces surpluses.
It promotes the creation of black markets.
The government needs to dispose of the surplus.
It might create firm inefficiency.
It eliminates allocative efficiency and generates welfare loss.
There are consequences for market stakeholders.
Consequences of price floor for stakeholders
Consumers - worse off as they pay a higher price
Producers - gain as they receive higher prices , and since goverment purchases surplus, revenue increases
Workers - likely gain as employment increases due to greater production
Government - lose, buying excess supply is a burden on budget
Minimum prices generate a deadweight loss to society because
The government has to buy up the surplus from producers to achieve the aims of its policy.
What is Indirect taxes and the graph for it
imposed on spending to buy goods and services
Types of indirect taxes
excise taxes
Sales taxes
aims of indirect taxes
collect government revenue.
discourage consumption of undesirable and/or dangerous goods.
redistribute income within the population.
correct negative externalities and socially inefficient allocation of resources.
Types of excise taxes
specific tax
ad valorem taxes
specific tax
fixed amount of tax per unit of the good or service sold
ad valorem taxes
fixed percentage of the price of the good or service
Consequences of indirect taxes for stakeholders
consumers - negatively affected due to higher prices
producers - negatively affected due to fall in price they receive and the fall in quantity the sell
the government - better off, as they earn revenue
workers - worse off, lower amount of output means fewer workers needed
society - worse off, due to underallocation of resources and decrease in social surplus
where id the deadweight loss on a graph
Subsidies
per-unit payments that are used to lower production costs and increase the output of the market
aims of subsidies for the government are usually
to increase revenues of producers.
to make basic necessities and merit goods more affordable to low-income consumers.
to encourage the consumption of a good or service that is considered beneficial to consumers.
to support growth of a particular industry.
to encourage exports and protect national industry from foreign competition.
to correct positive externalities, improving the allocation of resources.
What are subsidies and what does the graph look like
Assistance by the governments or individuals groups of individuals, such as firms, consumers, industries or sectors of an economy
Can take the from of direct cash payments or other forms of assistance such as low-interest loans
Subsidy impacts on stakeholders
Consumers - pay lower prices, better off
Producers - better off, as they lower production costs
Goverment - worse off, subsidy is burden on its budget
Workers - better off, more labour needed to produce extra output
Society - worse off, over allocation of resources, protects inefficient frims
